INSIGHTS: Skill – Based Investment Management: The Next Evolution in the Asset Management Industry

Pranay Gupta and Jan Straatman

Volume 4, Number 1, First Quarter 2006

In this paper, we discuss the structure of investment management organizations from a business model perspective, investment structure perspective, and return analysis perspective. We argue that the definition of a business model to align the interest of the asset owner and asset manager is critical to maximizing investment returns. Failure in this process leads to a vicious circle, both for the organization and the investments. Further, we propose that the investment structure of investment management organizations needs to evolve from an asset class demarcated and regional structure, to a global skill-based structure, where there are no asset classes and no regions, and only skills. As a result, asset allocation has to evolve to exposure allocation. In the proposed multi-strategy, exposure-based framework, the definition of alpha and beta needs to evolve to exposure premium and arbitrage return, and portfolio risk should be decomposed into intended and unintended, rather than into systematic and unsystematic.